Too Much of a Good Thing?

BCA Research yesterday made the case for seeing emerging market stocks as “fully priced” on an earnings basis. Or, if you prefer, they’re “no longer cheap.”

It doesn’t help that the MSCI Emerging Markets Index soared last year to the upper reaches of bull market history, rising nearly 80% in 2009. A chart in the January issue of The Beta Investment Report, published earlier this month, made this point in a way that only graphics can:

Is any of this related to the recent weakness in emerging market equities and related funds, such as iShares MSCI Emerging Markets (EEM)? Bloomberg News today advises that emerging-market stocks are “heading for their steepest weekly decline since October, as commodity prices dropped amid concern higher interest rates in China and proposed U.S. banking reforms will slow economic recovery.”

What we do know for sure is that gains and losses in the extreme tend to be reversed–eventually. Timing is always a question, of course. But if you weren’t at least a little suspicious of massive trailing gains in emerging market stocks for 2009, you weren’t reading the lessons from history.

Momentum is a powerful force, particularly in the short term. Traditionally it’s been on the short list of tools for traders. But momentum’s signals are valuable sources of intelligence for strategic-minded investors too, as a number of studies in recent years suggest. How you use this intelligence is open to debate, but then again so is everything else. In any case, keeping an eye on momentum for managing of portfolio of the major asset classes has appeal for the medium and long term, as Mebane Faber has detailed in a study that evolved into The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.

Is momentum a silver bullet? No, of course not. But it’s not chopped liver either. Momentum is one of several quantitative and qualitative tools for managing asset allocation. Strategic insight doesn’t come easy in the money game. But if you look hard enough, and keep your eye on a range of metrics, sometimes you’ll pick up a few clues.

James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers.

Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg, Dow Jones, Reuters.